China’s M&A boom is bringing real opportunities for UK companies who recognise the growing influence of Asia's emerging middle class and its focus on an innovation ecosystem.
The markets have been feeling the jitters ever since the Chinese economy has been reported to be slowing down. However, while the IMF has lowered its global growth projection from 3.4% to 3.2%, it has upgraded its estimate for China’s growth in 2016 from 6.3% to 6.5%(source: IMF). The world's second largest economy expanded by 6.9% in 2015. Although this was its slowest pace in 25 years, China’s growth is still higher than the US and the eurozone.
It is quite easy to get bogged down in the short-term volatilities of the stock markets as it affects global economic confidence. However, one must not overlook the bigger picture. China's outbound investments have been growing steadily over a number of years, with outbound foreign direct investments in 2015, relative to the previous year, experiencing an increase of more than 40% across the EU, and the UK a three times increase in deal values.
Priority to 'go west'
The One Belt One Road (‘OBOR’) strategy, advanced by Chinese President Xi Jinping, is expected to help upgrade China's economic structure to an innovation-driven economy as part of a long-term strategy. However, in the short to medium term, Chinese investors are looking for opportunities in Western European economies to help prepare them for the longer-term OBOR strategy.
China's 13th five-year plan clearly reflects its desire to invest in certain key strategic industries. These are likely to include, but are not limited to:
- healthcare and related services, to cater for the ageing population
- education, in light of the anticipated changing demographics following the introduction of the two-child policy
- advanced manufacturing technology, to enhance its local industrial capacity
- cleantech, renewables and related technologies and services that will help the country to deal with its environmental issues
- consumer brands, to meet the demands of an ever-growing middle class
- food and agriculture, to create a global supply chain to fulfil China's domestic demand, as well as to become an international player in this space
- technology businesses across a whole range of industries that will be seeing the impact of a growing middle-class consumer base.
As such, it is reasonable to expect that China's global trading will continue to grow along with its ambition to 'go west'.
The willingness of state-owned banks to lend to companies looking to make acquisitions in the developed Western economies is one of the key contributory factors towards the low-cost-of-capital environment in China. The ease of borrowing for Chinese buyers looking abroad for acquisitions is helping companies to implement their M&A strategies, with three-quarters of buyers being private companies last year rather than state-owned enterprises. This is consistent with the findings of the Grant Thornton Tou Ying 投英 Tracker 2015, released earlier this year, which highlighted the increasing role internationally of the Chinese private sector.
Supportive M&A policy in China
The drive to invest overseas (irrespective of the recent renminbi depreciation), coupled with initiatives that the Chinese authorities have been taking to help facilitate this cross-border activity, have created a credible environment for outbound M&A activity originating from China.
Hong Kong is an existing gateway for Chinese companies to undertake M&A overseas. Additionally, the setting up of the Shanghai Free Trade Zone to help facilitate Chinese cross-border investments and MOFCOM's (Ministry of Commerce and National Development and Reform Commission) relaxed approval requirements for Chinese outbound investments, enabling buyers to make overseas acquisitions without requiring detailed regulatory approvals, is evidence of the desire to lay out the infrastructure for further outbound acquisitions.
Recent examples of UK M&A deals completed include:
- China Travel Services of Kew Green Hotels
- the takeover of UK-listed Promethean World (an interactive learning technology business) by NetDragon (an online game and mobile internet platform developer and operator in China) at a premium of approximately 50%
- the takeover of UK-listed Palletforce (a pallet network distribution business) by Hong Kong-based investment company, EmergeVest, for a premium of more than 90%.
Partnering with experienced dealmakers
Influenced by a slowdown in China's economic growth and demand, many domestic enterprises are experiencing a continued decrease in their profit margin and thus are focusing on earnings-enhancing acquisitions.
A buyer being listed on one of the stock markets in China is not always an indication that it is experienced in international M&A. There are a large number of listed Chinese companies that have the desire to participate in cross-border M&A but currently lack the experience to implement such deals on their own. As such, a number of companies are looking to partner with a more experienced M&A operator (eg, a private equity fund) to undertake such acquisitions. A key component of any deal is for the buyer to be able to retain key management members and to offer appropriate incentivisation arrangements to help continue to grow the business globally, while also allowing access to the potentially phenomenally large Chinese market.
Favourable environment for acquisitions in the UK
The combination of potential target companies with strong growth prospects and attractive valuation levels makes the pool of UK-listed and private companies an appealing proposition for investors looking to build on their existing businesses or use the acquisitions as a platform for future bolt-ons. The UK has one of the most open regimes to M&A with a stable regulatory and political environment, which is why it sees a significant proportion of transactions involving overseas buyers.
At the time of writing, the FTSE 100 index is down approximately 12% and the FTSE AIM All Shares is down more than approximately 11% since their respective peaks over the last 24 months. As such, the timing seems right for Chinese investors to take advantage of these favourable valuation levels.
Although the uncertainty over the EU referendum and a potential ‘Brexit’ is creating some volatility in the short term, the reality is that the UK remains an attractive destination to do business, whether or not it is part of the EU. Inevitably, the depreciation experienced by the pound sterling also creates a favourable environment for foreign buyers to undertake acquisitions.
Growing appetite for Chinese buyers
UK-based companies considering an exit opportunity will no doubt be aware of the growing appetite of Chinese buyers actively looking to buy strong, profitable businesses in the UK and Europe.
Clearly, it is important to assess a potential buyer’s capability and experience of undertaking a cross-border deal. However, the fact that an interested party may not have previously bought a UK business does not in itself reflect on its ability or desire to implement deals. Chinese buyers have been busy acquiring businesses globally and the UK is now becoming a destination of great interest with an increase of more than 70% in announced deals in 2015 relative to the previous year. UK companies thinking about their future exit strategies should consider developing suitable avenues and build relationships that could give them access to potential Chinese buyers.
Assessing where the acquisition funds are based (eg, Hong Kong, mainland China, Shanghai Free Trade Zone or elsewhere) will help to provide an indication of the ease with which the buyer would be able to complete a deal. As such, Chinese buyers should ensure that the requisite funds are in place to implement acquisitions to avoid situations like the recent Anbang Insurance Group's failed attempt to acquire Starwood, which purportedly did not complete due to the relevant funds not being available for the increased offer levels.
For further information on China M&A, please contact Salmaan Khawaja, a director in our corporate finance team, on firstname.lastname@example.org.